Today, we’ll argue that there are no suitors interested in buying iiNet at the price it would take to pick up the company.

If Australia learnt anything from Telecom New Zealand’s many attempts to sell its ailing business AAPT, it’s that there really aren’t that many companies interested in buying large Australian Internet service providers. That list is broadly divided into just a handful of categories — other telcos, media companies looking to diversify into telecommunications, and generalist investment companies such as private equity firms who like to pick up valuable assets cheap, turn them around quickly and then flog them off for a profit.

With Telstra being basically prohibited from buying its rivals and increasing its dominance of the market, the list of Australian telcos who could buy iiNet is down to just a few, most of whom took a look at AAPT as well, before its consumer business was bought by iiNet last year. Of that list, none of the companies are likely iiNet buyers.

You’d think Optus would be interested, but the telco has long been hamstrung by its need to run all local investments past its SingTel parent, a fact which appears to have largely prevented it from buying Australian assets in the past. Optus is a cash cow for SingTel, and you don’t invest in cash cows — you bleed them.

In addition, Optus’ has recently been placing an increased focus on the company’s mobile assets, as opposed to its fixed-line broadband products. Telstra’s ownership of the copper network and the uncertainty wrought by the NBN means Optus is focusing on high profit margin mobile services it can actually control itself. Tried signing up for Optus HFC cable recently? It’s a pretty hard task … the network isn’t advertised anywhere and Optus doesn’t like to talk about it.

It’s a similar case when you go to Optus’ site looking for a pure broadband service. Optus just isn’t that interested in selling you broadband these days — it’s far more interested in getting access to your mobile plan, adding in a fixed-line broadband plan as well in a nice bundle if it can do so.

Looking at the other local players; with more than $200 million of existing loans on its balance sheet from previous acquisitions such as that of PIPE Networks, TPG would likely find it hard to stump up the capital to buy out iiNet. Macquarie Telecom is a business-focused telco which would founder if it bought consumer-focused iiNet, Internode’s just not big enough, and Vodafone has its own massive internal integration project to worry about before it starts to look outside its own walls.

Of the international telcos, it should be clear by now that very few consumer-focused multinationals have succeeded, or even demonstrated any significant interest, in building global fixed-line telecommunications brands. Primus’ weak as dishwater attempt to play in the Australian market is a great example of this in action. It is perhaps only Vodafone which has successfully built a truly global telecommunications company in 2011, and it’s done it on the back of cheaper and higher margin mobile networks; as Singapore Telecommunications is currently attempting to do throughout Asia.

On paper, you would expect companies like AT&T, British Telecom, France Telecom, Verizon and so on to be interested in expanding their global telco footprint into countries like Australia. But the reality is that it just hasn’t happened and won’t any time soon. The capital investment to do so has proven too steep.

Now to other potential suitors for iiNet’s hand.

Frankly, the only media companies who would want to buy iiNet are those with a broadcast television presence or aspirations; for example this morning the Financial Review mentioned Kerry Stokes’ Seven West Media as one potential option.

However, it’s far from obvious that media companies should shackle themselves to distributing their content through one broadband network, instead of all of them at the same time, and Seven has already demonstrated how royally it can screw up telco acquisitions, with its buyouts of Unwired and Engin over the past several years.

Sure, you can argue that pay TV operators like Foxtel are focused on one fixed-line broadband platform (Telstra’s HFC network) as a distribution medium and that a Seven/iiNet deal would make sense in this vein, with Seven’s content being added onto iiNet’s data and voice services for the ultimate triple-play bundle. But with its recent expansions onto Telstra’s T-Box and Microsoft’s Xbox platforms, it’s obvious that even Foxtel can see that content is becoming disaggregated from physical networks going forward. It wants to target all customers — not just those that belong to iiNet.

In short, at this stage, it is just very hard to envisage that a television broadcaster would be interested in picking up iiNet.

That just leaves private equity firms.

Now, there is no doubt that there has been a fair degree of private equity activity in Australia over the past few years. A consortium of companies led by Archer Capital picked up accounting software firm MYOB in early 2009 for in excess of $400 million, Queensland-based mining software company Mincom was bought in early January 2007 by Francisco Partners for $315 million, and those are just the most visible acquisitions.

However, there are several key differences between these sorts of buyout targets and iiNet.

Technology companies are generally high margin businesses. They have a core research and development capability which they try and keep as small as possible, while selling their products as widely as possible — often on a global basis. Often a company has a great product that is not being exploited to its full potential — so a private equity firm steps in to build global scale.

Nothing could be less true of telcos like iiNet, which are not truly technology companies or even, increasingly, infrastructure businesses like electricity companies.

We may think of iiNet as a networks company which develops and builds its own infrastructure across Australia and sells access to it. However, if truth be told, iiNet owns very little of its own infrastructure, with its services mostly being provided across Telstra’s copper network, with a few iiNet bits of equipment, typically in telephone exchanges.

And even those pieces of equipment are not great assets … did you ever consider, for example, that network equipment, like all IT equipment, starts depreciating in value as soon as you buy it?

iiNet’s only true asset is its customer base … a customer base which demands better value for money year after year, can easily churn to rival carriers like Internode, and is highly localised — based in Australia. And with Australia’s fixed-line broadband market being quite saturated, iiNet faces a dogfight trying to expand that customer base rapidly, even if it does (as it has been) pump marketing money into Australia through a fire hose.

The only easy way for iiNet to expand quickly is through acquisition. Coupled with the fact that the company is already pretty slim and well-managed … you have to ask why any private equity firm would be interested in buying the ISP.

None of this means that there won’t be organisations interested in buying iiNet. No doubt there will be many corporate rulers run over the company over the next few months as Amcom’s 23 percent stake disappears into the market. However, the kicker is the price. All of the various players I highlighted above will have various levels of interest in iiNet. However, the fundamental incompatibilities I outlined today will mediate against those same players making a commitment to a takeover attempt — unless the price is so dirt cheap it becomes irresistable.

Stay tuned for another article tomorrow in which we’ll argue again that iiNet won’t be bought … but for a different reason this time: Because the company is still, fundamentally, a family company without mature management structures in place.

13 COMMENTS

This is why government investment or at the very least incentives are the only way a fixeds Telecoms can possibly hope to expand. The market is just to static, revenues just to low, and there is little to no repeat buyers (once you’re on the books you’re unlikely to request a second service), and the products are just to close in value (you can only really differentiate yourself with customer service, bundling discounts, and non essential ease of use products (read T-Hub, BoB, Fritz!Box).

The service is also considered an essential commodity to an increasing sector of the market. However it much easier to commoditise this with wireless based technology which, if this trend continues, will put ever increasing strain on (finite) spectrum.

In short we can’t trust the market to deliver this commodity under its own power, in the same way the market refuses to install power in many homes in Africa and Asia because they cannot raise their prices in order to find money to invest in expanding their footprint (There was a good TED talk about Charter Cities on this very problem).

This article is a little quick to dismiss TPG as a serious suitor due to its debt level. There’s plenty of equity in TPG – about $450M and TPG has a market cap of ~$1.4B – more than 3X that of iiNet. so TPG in financial terms is a much larger company. Key metrics such as TPG’s operating margins are impressive and significantly superior to those of iiNet. TPG’s Debt is 36% of overall capital, hardly a stretch. iiNet debt is very low at 18% of capital. If there is no takeover premium in the current iiNet share price its market cap currently $440M, might rise by about 30% to say $570M. If TPG were to acquire iiNet at this price, TPG’s debt would rise to $1.0B, or 80% of overall capital. and I agree that the banks would probably not agree to such a high debt level. However, the equation would change considerably if there was substantial equity funding – iiNet has a large proportion of institutional shareholders who would be amenable to an equity swap if the deal was sensible. I reckon TPG has the capacity to do a deal but the real issue at TPG would probably centre around whether the Teohs, who hold 36% of the shareholder equity, have the capacity to increase their equity or are willing to dilute their interests. Soul Pattinson, the only other substantial shareholder, holds a 27% stake but in the long term is probably looking to exit rather than increase its stake.

Internode is discounted in the article as ‘too small’ but should not be written off quite so quickly. Internode issued solid results in 2010 and assuming its financial condition has not substantially changed, probably has the capacity to acquire iiNet. However, Internode does not have a history of growth by acquisition. A capital raising would probably be required and this might require an IPO. Its MD/owner would likely need to cede a degree of control in this situation, something that might not sit comfortably. Internode and iiNet have quite different corporate cultures but at the top level Malone and Hackett have a strong mutual admiration for one another’s business acumen in the ISP sector – something that would bode well if there was to be a merger negotiation.

Jason, Internode and iiNet are completely separate companies and there is no cross shareholding.

As for your “Breaking News” – there is no evidence that Internode has acquired a 23% stake in iiNet, equivalent to the recent Amcom stake.

Au contraire, last Friday Amcom announced plans to conduct an in specie distribution of its remaining iiNet stake directly to Amcom’s shareholders (Amcom has already sold 4.5M iiNet shares and holds a further 31M approx). If Amcom shareholders approve the in specie distribution plan, they will end up directly holding shares in iiNet with the share distribution being pro-rated against their existing Amcom shareholding. No money will change hands. If the distribution goes ahead we would expect to see increased liquidity in the on-market ASX trading of iiNet shares – Amcom has a relatively large proportion of retail shareholders.

Hi Jason, for the record I am closely involved in the industry and take it very seriously. I certainly don’t joke about it. In particular, I see it as dangerous to promulgate incorrect information in jest that might be prone to misinterpretation. Sorry, your joke is not regarded as funny by the serious people in the industry.

Has seven network does any better with its owning of Vivid Wireless? Lots of noise but its 4G technology really hasn’t received that much media attention. And regarding market share they really aren’t knocking anyone over at the moment.

In my opinion at the moment, Vodafone’s issues have done nothing if highlight the companies strategy of a predominately wireless only strategy as flawed. With the ever increasing demand for data over wireless, it shows that the Network (in all countries not just ours) is coming under increasing strain. Vodafone has recently paid TPG (pipe networks) to run fibre between towers to upgrade capacity – What this possibly indicates is that Vodafone is more likely to be in a position to capitalise on smaller ISP’s here than anyone. Vodafone’s superiors are obviously taking notice of the trouble the Australian branch – and in some countries overseas – and are looking to spread into fixed line as well.

I certainly wouldnt discount Vodafone under any stretch – ideally they’ve got the most to lose with a failed venture here – I’d expect them to rise sharply very soon.

I really feel Vodafone’s getting a well deserved media and public hammering, but from what Ive seen recently due to both personal and professional experiences – Vodafone are far from done. Vodafone PLC in my opinion is using VHA to test what could possibly be a total restructure of how they do business. Buying smaller ISPs like TPG / iiNet / Internode could possibly give them more leverage than they already do now. iiNet is in a prime position to be bought up by Vodafone – and i’ll bet Vodafone’s watching the NBN intently, knowing full well that they have near infinite cash flow to totally domiate the ISP field.

Call Vodafone what you like while theyre still restructuring, but if they do aquire iinet – watch this space.

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Written by Delimiter Publisher Renai LeMay, The Frustrated State is the first in-depth book examining of how Australia’s political sector is systematically mismanaging technological change and crushing hopes that our nation will ever take its rightful place globally as a digital powerhouse and home of innovation.

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